Key hearing on Detroit's historic bankruptcy begins in U.S. court

Downtown Detroit is seen from a vacant lot, looking south along Woodward Avenue, Michigan July 21, 2013. REUTERS/ Rebecca Cook

DETROIT (Reuters) - Detroit will not recover, and it may not survive as a major city if its debts are not significantly reduced during bankruptcy, a city attorney told a federal judge at the start of a critical phase of the case on Tuesday.

As Detroit’s state-appointed emergency manager Kevyn Orr looked on in the courtroom, Bruce Bennett, an attorney for the city, sought to convince Judge Steven Rhodes that Detroit’s 1,034-page plan to adjust $18 billion of debt would save the city.

“There is no doubt, your honor, that progress has been made, but Detroit is still a city in distress,” said Bennett, an attorney with the Jones Day law firm, in his opening statement.

The plan is aimed at reducing Detroit’s debt by about $7 billion and reinvesting as much as $1.7 billion in the city, according to Bennett.

Detroit made history nearly 14 months ago when it filed the biggest-ever Chapter 9 municipal bankruptcy. The confirmation hearing to determine if the city’s plan to exit bankruptcy is fair and feasible began on Tuesday and is scheduled to stretch through Oct. 17.

In a pretrial conference earlier on Tuesday, Gregory Shumaker, another Jones Day attorney representing Detroit, told Rhodes the city may not finish laying out its case until the first week in October.

Bennett is expected to complete the city’s opening statement on Wednesday morning. Supporters and opponents of the city’s plan collectively indicated they will need at least four hours to deliver their opening statements.

Detroit has settled with most of its major creditors, including the city’s retired workers and two pension funds, but two insurance companies - Syncora Guarantee Inc and Financial Guaranty Insurance Co - have emerged as major objectors to the plan. Both guaranteed payments on $1.4 billion of pension debt the city is seeking to void and both are facing recoveries of just pennies on the dollar.

A City of Detroit Water and Sewerage man-hole cover is seen along Jefferson Avenue in the Delray neighborhood of Detroit, Michigan December 13, 2013. REUTERS/Rebecca Cook

A so-called grand bargain would tap into $366 million pledged by foundations and $100 million from the Detroit Institute of Arts over 20 years, as well as a $195 million lump sum payment from the Michigan government. The money would be used to ease pension cuts for city retirees and prevent the museum’s collection from being sold to pay creditors.

The bond insurers have objected to the lopsided treatment of similarly situated creditors embedded in the city’s plan.

Bennett said the hold-out unsecured creditors have no grounds under Michigan or federal bankruptcy law to push the city to sell or monetize the art, which was valued at $8 billion in one appraisal. He added that there was no evidence that parties to the grand bargain colluded in any way.

As for other revenue-raising measures, Bennett said hiking taxes would risk sending Detroit, which already has the highest rates among Michigan cities, further into a downward spiral.

“Raising taxes now is not compatible with the goal of saving the city,” he said.

Earlier on Tuesday, Rhodes denied pretrial motions by the bond insurers that sought to limit city evidence in the trial that was in some cases derived from confidential court-ordered mediation. The judge granted a motion by Syncora to exclude certain testimony by Kenneth Buckfire, a key Detroit restructuring consultant.

If Rhodes determines the plan for fixing the city’s finances is fair and feasible, he can impose its terms on hold-out creditors in a practice known as a “cram-down.”

But questions have bubbled up in recent weeks about the city’s ability to recover from years of fiscal stress, and there remains the possibility that Rhodes could not confirm the plan.